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Bringing the Summer of 1927 to the Forefront


The Fed's decision in August 1927 is often cited as the culprit that fanned the flames of frenzy into 1929.

The first cut is the deepest,
Baby I know the first cut is the deepest
The First Cut Is The Deepest (Cat Stevens)

In the summer of the seventh year of the decade, with the DJIA near all-time highs, the Fed slashed the discount rate.

No, I'm not referring to the action of the Federal Reserve last week. I'm referring to August 5, 1927 when the Fed cut the rate from 4% to 3.5%.

Like the Fed's ease in 1998 in the middle of the raging bull of the late 1990's, which threw fuel on the speculative frenzy of the time, likewise the Fed's decision in August 1927 is often cited as the culprit that fanned the flames of frenzy into 1929. Adding injury to insult, many scholars of the era blame the ill-advised Fed's actions for exacerbating the Great Depression.

Will this summer's surprisingly large decrease of one point in the discount rate in just over one-month lead to another equity mania? Ironically this summer's Fed action coincides with the release of the Maestro's memoirs, when Greenie is being taken to task by more than a few astute observers of the financial market for keeping rates too low for too long after the technology bubble imploded in 2000.

His slash and burn rate policy fostered the biggest real estate bubble on God's green earth, not to mention a conga line of hedge funds smoking opium, O.P.M. (other people's money) through the leverage bong. Interestingly, stocks rose after the Fed cut in the summer of 1927 prior to suffering a quick 10% setback in October of that year.

The lesson seems to be that when excess is not allowed to be purged, and recalcitrant regulators refuse to regulate, and simply encourage more excess, there is a price to pay that is greater than the price might be if wounds in the system were cleansed initially. However, when a Band-Aid is applied to a gash an infection can fester, putting the body financial at risk. Kind of like Marie Antoinette saying to the man behind the guillotine – "Just a little off the top, please."

The thing about contaminating credibility with the people is that credibility is one of the scarcest commodities to begin with, and when squandered it is hard to recapture. Did the Fed in 1929, in an effort to regain its credibility, turn the screws too tight for too long, leading to the worst crash in U.S. history?

Sadly, the Fed, which was presumably created in 1913 in order to avoid booms and busts and to preserve the sanctity and stability of the currency, seems to have actually accentuated economic waxing and waning, as well as obliterating the value the dollar at the same time.

Isn't it interesting that the book, The Creature from Jekyll Island, about the true origination and character of the Federal Reserve, is out of print?

In October of 1987 the market crashed. Real estate was strong, the economy was firm, but the dollar was an issue. In 1929 when the market crashed the dollar was strong and the economy was firm. What's wrong with the current picture:

  • The Fed is creating all the money that's fit to print.
  • Real estate is suffering worst decline in a generation.
  • The dollar is making forty-year lows.
  • The economy is soggy and may be on the verge of tanking.

Economists expect the worst Christmas since 2001 as consumers react to the negative wealth effect from the decline in the value of their homes.

But, hey, let's buy stock. Let's buy stocks because there may be someone behind us that will pay even more. Does anyone stop to think what is behind the demand side for stocks? The large franchise multi-nationals may be earning more on the dollar translation, but what is the actual value of those dollars when translated? Seems like some serious circular logic from outside the loop to me.

They say the first cut is the deepest. With the dollar flirting with record lows, the recent ease by the Feds may be a fork in the Rubicon. In other words, in using a sledgehammer rather than a scalpel, the Fed has shown its true colors in bailing out its constituency and throwing the working man's dollar under the bus. Rather than help the ailing mortgage market, the Fed's actions have caused long rates to which mortgages are tied, to ratchet higher.

Hence, although the indices have recovered almost all their losses from the summer, more panic in the financial markets and in the economic data can be expected: turbulence should be the rule of the day in the fourth quarter.

This week has seen stocks in mark up mode. However, with the S&P seven weeks from the mid-August surprise by Bazooka Ben, and seven months from the Spring Swoon, and seven trading days from last weeks Fed Bear Raid, it should be fascinating to see what, if any, liquidation shows up next week in the new quarter.

Editor's Note: Want more of Jeff's insight and trading ideas delivered to your inbox daily? Minyanville is proud to announce that we have launched Jeff Cooper's Daily Market Report, complete with Jeff's day trading and swing trading setups. Email Josh Sander for more details and how to sign up.
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No positions in stocks mentioned.

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